Signature's loan discounts contextualized
Signature's loan discounts contextualized
The market that the FDIC is selling into, as told by anecdotes
Signature Bank entered receivership earlier this year because the FDIC feared it would undergo a bank run and collapse, much like Silicon Valley Bank. The FDIC is now liquidating the former bank’s assets. Of particular interest are the rent regulated multifamily loans and the office loans because of the distress that has befallen office and multifamily assets. Fun fact: firms with any connection to the underlying assets – the properties or the owners – were barred from bidding on the loans, thus shrinking the bidding pool. Today I’ll provide context into the world of rent stabilized multifamily properties and try and illustrate why the loans are expected to be so deeply re-priced, and what that might portend for the industry.
Let’s start with context
Back in December 2018, an owner in Brooklyn contacted me to express his interest in selling his properties. He’d owned the properties for a while, but he was not transaction savvy. Against my better judgment, he decided not to hit the market quickly and sell. He took his time, courted investors directly, and entertained broker pitches. I mean, who wants to pay fees, right?
Weeks turned to months, and I watched on the sidelines as the rent laws of June 2019 passed, while the seller still had not committed himself to a path forward. Prices started to fall almost immediately after the passing of NY’s strict rent regulations. The business plan “play of the day” for 6 family properties like his was to perform expensive renovations and completely transform apartments to get state permission to obtain meaty rent hikes. That went out the window on June 14th, 2019.
The properties ended up selling at the very end of 2020 for a combined $1.75MM. Back in February of 2019, I had collected an offer from an investor in my office for $2.3MM. That was without trying to sell the property too actively. Still, that difference of $550,000 is close to a 25% price reduction.
What’s the takeaway?
You should listen to my advice.
But also, the rent regulations of NY had a huge effect on property values and thus transactions. Transactions slowed down considerably during and after 2019. There was a 25% drop in the number of deals closed in 2019 in Manhattan and the Bronx compared to 2018. This decline grew steeper in 2020. Some Covid scares contributed to this, but a lot of the reduced activity was in response to the changes in the rent regulations. Last year’s sale counts were lower than each year dating back to 2018 in all boroughs except for Brooklyn. Recall that 2022 was when investors in NYC and other parts of the country were busy doing victory laps and exiting deals purchased only 2-3 years earlier being sold for premiums due to low interest rates. Despite this, NY multifamily sale counts in 2022 were comparable to 2018 figures. That’s what happens when your state legislature passes an iron-clad package of bills that caps hockey stick rent growth.
Multifamily properties in NYC haven’t just seen their values reduced because of tighter controls on rent stabilization, but also thanks to higher interest rates. The chart above shows fewer sales, which I attribute to 2019’s HSTPA (tighter rent controls). But, when you add higher interest rates to a somewhat beat-down environment, things get even more beat down. You would expect further reductions in transaction counts. Since that data for 2023 is not out yet, let’s look at an example.
Example #2:
In 2022, I sold a 16 unit building in Brooklyn for $3.7MM, or $230,000 per unit, and 100% subject to rent stabilization. I sold it for an owner whom I’d met initially in the summer of 2018. When I’d valued his building in 2018, I pegged the price per unit at around $300,000, or a price of around $5.0MM. There was some upside in the rents that would grow over time as the neighborhood evolved. Further, turnover was going to be high due to the small unit size, and the rents not being that low to begin with. That’s $1.3MM of value lost due to rent laws.
But what about the effects of higher interest rates?
$3.7MM was a strong price at the time, and many bidders offered lower ~$3.2MM or less. The reason the buyer was able to pay top dollar at the time was due to great financing. The loan the purchaser secured had an interest rate of less than 3.5% with a 5-year term, covering 75% of loan proceeds with a 30-year amortization schedule. If that purchase were made today, the interest rate on the mortgage would be between 6.75%-7.25%. If the buyer were solving for neutral leverage day one (cap rate on cost = interest rate), with the future expectation of rent growth, then the value today would be closer to $2.8MM. $1.3MM was lost due to the rent regulations and $0.9MM of value was wiped out thanks to hiked interest rates. That’s a $2.2MM loss in value in 5 years, or a +40% reduction in price.
The rent stabilized segment of the Signature Bank loan sale is important to watch because the price at which the deal is struck will determine whether property owners and investors run into trouble when it comes time to refinance. The FDIC has a statutory obligation to preserve affordable housing for low/middle income households. This means fewer foreclosures. Since the FDIC is holding on to 95% of the $15Bn rent stabilized loan portfolio, it means it will have a rather large say. This means fewer foreclosures. Oops, I said it twice. But what about other bank loans? Signature made A LOT of multifamily loans in NYC, but so did Dimes Savings Bank, NY Community Bank, Valley National, JP Morgan Chase, and others. These loans will be marked down A LOT. Perhaps these lenders follow the FDIC’s likely lead and offer work outs, or maybe they don’t.
The portfolio will be sold for a large discount because of the reasons I explored earlier in this piece: higher interest rates and reduced values due to rent regulations. Let’s think about a $10MM property sold to someone who buys it with $6MM in debt and $4MM in cash (equity). If the value of the property drops by 20%, then the property is worth $8MM. The debt load is still $6MM, but the equity gets reduced to $2MM. It’s impossible for borrowers who don’t have access to outside funding to bridge that $4MM gap. If the loans were bought close to par value, and absent any appreciation, that 20% decline in value will have to be measured against the full loan amount (0% decline). That’s hard to work out. That causes distress.
If market forces alone were governing the sale of the Signature loans, I expect the buyers would segment the loans into tiers of risk and re-sell them to distressed investors with the capabilities and know-how to foreclose on owners unable to refinance. This won’t happen with Signature loans, but it might happen with other lenders that have similar loans but none of the FDIC oversight. Smaller banks with less liquidity, may opt to sell to shore up capital reserves. To some lenders, selling loans would be better than working things out and making fewer new loans. Buyers of those loans will need to make sure they understand market fundamentals. In NY, fundamentals include understanding the political environments and having reliable insight into not-yet-passed-regulations-that-are-about-to-pass.
Sources: Property Shark, The Real Deal